Friday, August 8, 2008

Continuing from my last post on healthcare, I will briefly give my two cents worth on the problem of Social Security.

The debate on whether Social Security in the developed world is going to be insolvent has been going on since the 1970s. Primary reason again is the anticipation of massive numbers of boomers retiring en masse. Add to this the fact that people are living longer.

When you add the numbers of boomers who will start taking benefits to the numbers of existing elderly who will still likely continue taking benefits, you have a potential recipe for fiscal disaster. The average life expectancy has been increasing every year, as great numbers of the existing elderly continue to outlive even their own previous expectancies.

To alleviate this, and to lengthen the solvency of Social Security, several reform proposals have been proposed, and some have been enacted. The proposals revolve primarily around three legs:- Decreasing retirement benefits- Increasing contribution of those still working- Increasing the retirement age, and hence, the age when people start taking benefits

Decreasing benefits can only go so far before Social Security benefits become entirely meaningless. Ditto increasing contribution from workers. After all, those still working have their own personal expenses, still have growing families and mortgages and, most now have to save up more personally for their own retirements, in anticipation of declining Social Security benefits.

That leaves increasing retirement age as the only reform that can potentially go on indefinitely.

An alternative proposal under discussion is to turn Social security into a defined contribution fund. Currently, it is akin to a defined benefit fund, where the recipients are guaranteed a certain pension income, no matter how long in retirement they live. In a defined contribution program, while the pension income will still be guaranteed for the life of the recipient, the amount of benefit received will fluctuate, depending on the current financial market returns of the amount that they have contributed to the program.

This is interesting, given that it is patterned after the existing structure of private insurance and pension programs. But this still leaves retirees with the risk of receiving in some years, perhaps for many years, benefits that are in no way sufficient to support their needs. Remember, in times of high inflation, just when the cost of living is increasing, that’s also the time when financial returns of investments go down, and hence will lead to lower benefits under this proposal.

Let me add another option for retirees. It has nothing to do with Social Security reform. After all, I am on the camp that believes it can only be reformed so much, before it eventually becomes insolvent due to increasing numbers of elderly taking benefits. My proposed option is retiree migration.

If a retiree can expect a diminishing pension income in retirement, it starts making sense to live where costs of living are significantly lower. Previously, American retirees made Florida into a retirement haven. But cities in the same economy will still have proximate costs of living.

That then leads to retiring in cheaper economies. The developing world, specifically countries that do not have a history of bubble economic growth. The influx of currency from retirees from the developed world coming to spend their retirement days there will likely be beneficial to these economies, so many countries will probably be open to this.

The influx of money from retirees, if in large enough amounts, could potentially increase the cost of living in these developing countries, thereby making the initial benefit of moving to that country disappear. That is why a solution such as this needs to be two-pronged, and reciprocal.

Essentially, the biggest consumers in any economy are those still working, since most of them still likely have growing families, are yet into their wealth accumulating years, and buying their homes for the first time. If you have large amounts of these working age people living alongside people living on retiree income, the retirees will always lose out.

So, a countervailing strategy is to allow migration of many of the productive working age population of these developing countries to the developed world. This is assuming that the developed world continues to achieve the highest productivity gains in the world. If the developed countries slow down their productivity gains, that takes away the incentive of the working age population of developing countries to move, since added migration to a developed country whose economy doesn’t grow sufficiently enough will only decrease the over-all standard of living there.

But then, any economy that attracts more of the productive working age people is likely to increase its productivity over that of another country that doesn’t, and certainly over that of one that loses them.

Hence, the increased growth in economic development of a country that gets more working age people will likely attract more of them, leading to a virtuous cycle of continuing the productivity gain. The country that loses these workers will essentially experience a fall in its standard of living, making it more affordable for people living on retirement income from the developed world. And for as long as money trickles into these countries to support the retirees who have decided to move there, an equilibrium could be achieved where the country losing productive people will cease declining its standard of living at a certain point.

This scenario is similar to what has been experienced by cities within the same economy. Productive people move to where their efforts can enable them to build more wealth, while retired people move to where the cost and pace of life is more conducive to their state in life.

The difference this time, the migration will be global. But hey, goods and capital already have free mobility in our globalized world. The only major ingredient that needs to freely move around are the people. In a world where everything else is mobile, it doesn’t make sense to put a constraint on one factor of the economy. That will only create bottlenecks to growth, and economic hardship across the world.

The next stage of globalization, if we are to derive the full benefits of globalization, will involved moving people to where they will best achieve a quality of life. This experiment could start with the retirees.

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.